It's no secret that in 1999 the
was up 85% and the
barely broke 20% for the year. And that seismic difference seems to be rolling into this year. It's also no secret that 177 funds returned more than 100% last year. Previously, only six funds had cracked the 100% barrier in one year.
Makes you want to get a piece of the action if you're not in on it already. Before unwrapping some interesting information about the elite 177 funds, however, there are a couple of things to keep in mind.
First, real managers are buying real stocks. Even through a monkey could have darted his way over 100% last year using Nasdaq stocks, it's not a brainless game. For instance, check out the performance of the following five glamour tech stocks for 12 months through Feb. 25. They're all well off their highs:
While I haven't taken a poll, I know everybody didn't buy low and sell high. Nobody is that good, at least not consistently. We know that most mutual fund managers who were in tech last year did pretty good. That's the point -- if you're in a hot sector, you'll do great, but the opposite is also true. If a sector turns cold, as tech did in 1997, even a great manager can't save you.
For instance, the No. 1 growth fund over five years through 1999,
Firsthand Technology Value, was managed by Kevin Landis. In 1997, when tech was having a bad year, he was up only 6.5%. Two years later, he's up 190%. Was Kevin a lousy manager in 1997 and a good one in 1999? No way! It just shows that sectors run hot and cold.
The second point to keep in mind is that you increase risk when you abandon a classic asset allocation strategy. That strategy dictates that you will always have a percentage of your money in different asset classes. Some of those asset classes will be out of favor and some will be in favor at any given time. So, you'll probably do lousy in part of your portfolio, while doing great in the rest of it. The reason for using an asset allocation strategy is not to increase short-term returns, but to reduce risk and smooth out the ride. Over the long term, you'll probably do just fine. But it takes patience, and in these times of immediate gratification, few people want to wait.
That doesn't mean you can't be opportunistic within your asset allocation strategy. For example, I combine at least three major components in a portfolio. First, if someone is retired or will have a need for money during the next three years, that money goes into short-term fixed-income funds (as I explained in my
Aug. 19, 1998 column). Second, the balance of the portfolio is built around what I consider good solid core holdings. Third, moving away from the core, I move money into sectors that are performing. This kind of move is gradual. In most cases, I'll move in late and get out late. The percentage put in these positions depends on how much risk you're willing to take. Admittedly, this approach places more emphasis on the "art" rather than the "science" of investing, and it increases short-term risk.
With that background, the question a lot of people ask is: Is it possible to pick a fund in advance that will significantly outperform, as those 177 funds did in 1999? To help answer this, here are some facts from
about those funds:
Morningstar covers more than 11,000 funds. Of these, 800 are five-star funds and 1,800 are four-star funds.
Here is a quick recap on the star system. The top 10% of funds in each investment class (domestic equity, international equity, taxable bond and municipal bonds) receive five stars; the next 22.5% get four stars; the middle 35%, three stars, the next 22.5%, two stars; the bottom 10%, one star. (Funds less than three years old are not rated.) Morningstar president Don Phillips has stated many times that a star rating is not a predictive measure or a buy/sell recommendation. The following breakdown of 1999's triple-digit fund performers illustrates this point very clearly:
Obviously, picking a winning fund in any given year requires more than star gazing.
If you can do the following consistently, you'll always have a winner:
Pick a style of management (growth or value) that is working. Growth has worked better than value for at least two years.
Select the best manager within that style, or select a proven manager who is flexible in style.
Select winning sector funds that match your ability to handle risk.
Select a fund that invests in the size of companies you think will be winners. For instance, some small-cap growth funds and mid-caps have been doing great.
In general, pick a four- or five-star domestic equity fund. I know that stars don't predict performance, but they do indicate whether a fund had a decent record. (Be sure the manager who compiled the record is still with the fund.)
Always have a significant part of your portfolio in proven core funds.
You don't need to pick the most winning funds every year, you just need to pick funds that are doing well relative to their risk. It's consistency over time that counts. Have a great week!
Vern Hayden is a certified financial planner in Westport, Conn. He is a financial consultant and advisory associate of Financial Network Investment Corp. He also is an owner of Hayden Financial Group. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback at